The Unicorn of DeFi

Uniswap is the largest decentralized exchange in crypto

Imagine, just for a moment, that Google, in its early days, gave you GOOG shares for doing searches…

or that Facebook gave you shares for setting up a profile…

or that Uber rewarded you with equity of the company for riding their cars.

Well, that is what Uniswap, crypto’s largest decentralized exchange, and Ethereum’s largest application, did.

The protocol, with a current market cap of USD 3,5b (fully diluted), surprised the crypto community with the issuance of its new token, $UNI. The protocol will issue a total of 1 billion tokens. The particularities are in the token distribution model: 60% will be distributed among its users. This is far more than for investors or even the founding team. And 15% of the tokens were distributed retroactively among its users!

Allocation of $UNI tokens

How this distribution event took place?

Every Ethereum address that interacted with the protocol at least once was allocated 400 $UNI, which at the time of writing is equivalent to USD 1.400. Users that staked liquidity (aka “Liquidity Providers”) received even more. Even users who tried to use the protocol but failed (fail transactions) were rewarded. The funds were allocated through a mechanism known as “airdrop”, in which tokens are distributed automatically among selected Ethereum addresses at no cost for the users.

This unique retroactive distribution model is one of the most democratic and decentralized token distribution events in the history of crypto. At times of writing, 196k addresses have claimed more than 120m $UNI tokens. In DeFi, it is common that users have several addresses, so the exact real number of users that have claimed $UNI tokens is unknown, but it is still very significant.

Why is this distribution event a big deal? The first reason is that it generates, automatic, decentralized ownership to its users. The majority of the protocol will be owned by its users, not by investors or the founding team. Actual users and early believers of the project become shareholders of the project. What a way of bootstrapping a loyal community!

As we will see, there are some general similarities between crypto token holders and traditional shareholders of a corporation. However, there are also important differences. The main one is that token holders don’t own a share of a company, but rather a share of a platform. Because of networking effects, the value of the platform grows exponentially with an increasing number of users. The exponential growth of the value of Uniswap in the last months confirms this.

Diagram illustrating the network effect in a few simple phone networks. The lines represent potential calls between phones. As the number of phones connected to the network grows, the number of potential calls available to each phone grows and increases the utility of each phone, new and existing. Source: Wikipedia

Second, is perhaps the most significant wealth distribution event in the short history of DeFi. USD 525 m worth of equity of the protocol was distributed automatically to the community. And in total 60% of a USD $3,5 b project will be allocated to its users. All of this in times of COVID “stimulus checks” and a growing discussion about Universal Basic Income (UBI).

What is $UNI good for?

$UNI token resembles in some ways an equity instrument of a traditional corporation. It gives its holder voting rights (political rights) and potentially, revenue share(economic rights).

The primary function of the $UNI token is governance over the protocol and its treasury. Token holders can vote over protocol development and also over future revenue distribution. If token holders vote for it, they can accrue part of the value generated by the platform.

What revenues are generated by Uniswap? Mainly transaction fees that traders pay when they use the exchange (there is a 0,3% fee for swapping tokens). The governance contract contains a “fee switch”, which if activated, will enable holders to earn a portion of the protocol fees.

This entails considerable economic value for the token holders. Uniswap is the second protocol in crypto that generates most fees, even more than Bitcoin!

Fees are generated by the top crypto protocols. Source: cryptofees.info

What is Uniswap?

Uniswap is the largest DeFi protocol and the most important decentralized exchange. It has an average volume of USD 350m per month. This decentralized exchange works a bit differently than traditional exchanges you may already know. Unlike traditional exchanges, in Uniswap you don’t have a counterpart which stands at the other end of the trade. Instead, there is a pool of assets (aka liquidity pool) managed by smart contracts. Technically one trades directly with the liquidity pool (peer-to-smart contract). Anybody can provide capital to these pools and receives a portion of 0.3% of the fees paid by traders.

Uniswap is currently the top DeFi protocol with over USD 2 locked. Source: DeFiPulse

The growth of Uniswap this year is exponential, like the rest of DeFi. It has been so successful, that trading volume has matched decentralized exchanges like Coinbase. The protocol, with just 10 employees, is reaching the same volume that a company with 1200 employees that will soon go public!

Uniswap liquidity: Source: Dune Analytics

Uniswap is one of the basic building blocks of DeFi, and one of the first protocols that you will encounter in your DeFi journey. It permits to trade any type of crypto asset, and it also permits to list any asset and create automatically a market for it. This is a huge feature that will revolutionize capital markets. In traditional finance, the process of listing an asset in public stock markets requires for example an IPO and requires considerable capital and time investment. Even the process of listing a crypto asset in centralized exchanges like Coinbase was until recently a costly and lengthy process.

Not anymore. Now, with Uniswap, anybody can list an asset, permissionlessly. If enough liquidity is provided, a market can be automatically created for any kind of asset. One of the most important functions of Uniswap is therefore an Automated Market Maker (AMM). This is an evolution of market makers, which play an important role in traditional finance. We will dive deeper into this important role in a further article.

Further, Uniswap is arguably the most decentralized and credibly neutral protocol in DeFi. For this reason, it has become an essential piece of infrastructure in the DeFi ecosystem. According to the protocol sink thesis, developed by Ryan Adams and David Hoffmann, neutral, decentralized protocols are more likely to prevail and capture more value in the long run.

Uniswap is a very “dense” protocol in the Protocol Sink Thesis

What if I missed the airdrop?

If you didn’t receive any $UNI rewards, there is still an opportunity to earn some $UNI! with Uniswap’s yield farming program. If you deposit your funds in one of the four eligible pools:

ETH / USDT

ETH / USDC

ETH / DAI

ETH / WBTC

you will receive as reward $UNI tokens. Each pool will distribute weekly 583k UNI tokens, at current market prices is around USD 2m per pool. The exact value depends on the price of UNI which can be very volatile.

You can calculate your potentials returns here.

By depositing your funds, you turn into a liquidity provider (LP)

4 pools are initially eligible for “farming” $UNI tokens

We will cover about specificities of investing in Automated Market Makers in a future article. For now, you need to know that if the price of the trading pair varies, you can suffer impermanent loss. For a short explanation of what this means, see here. So if you are bullish on ETH, it might be better to opt for the ETH / WBTC pool, as these assets could be more correlated than the ETH / stablecoin pair.

Remember that the liquidity program will be open for 42 days more! For an excellent tutorial on how to earn UNI as a liquidity provider, look here.

P.D. Neither the author nor Blue Swan has a commercial relationship with any of the projects mentioned in this article. Any comment is purely based on independent criteria and conclusions based on the author’s experience. The author has $UNI holdings. The content of this article is for academic and educational purposes only. This is not financial, tax, or legal advice. Please do your own due diligence and research.

Blue Swan Academy is an educational platform for blockchain-powered economies, focused on the legal and financial industries. Please check out here our current offering.

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Head Blockchain Academy at Blue Swan. Blockchain Law. Decentralized Finance. Online training

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Juan Escallon

Juan Escallon

Head Blockchain Academy at Blue Swan. Blockchain Law. Decentralized Finance. Online training

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